Thermo Fisher Scientific Inc. (TMO) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Doug Schenkel from the Cowen life science and diagnostic tools team. It's my pleasure to welcome Marc Casper, Thermo's Chairman, President and Chief Executive Officer, to the 41st Annual Cowen and Company Health Care Conference. Thanks for being here, Marc.

No, it's great to be with you, and I look forward to being with you in person as well, hopefully in the near future.

Yes. Hopefully, I think there's hopefully some light at the end of the tunnel here. So it will be good to see you in person soon.

So Thermo has been one of our top large-cap tools picks for really the better part of the last decade, and this continues to be the case today. I think there's a lot of things to talk about that will make it obvious why that has been and continues to be the case, at least in our opinion. Our goal for the next 30 minutes is to really cover 3 things. The company's response to COVID-19 and as we kind of building off of what we just talked about as we think about, hopefully, light at the end of the tunnel, how we should think about the outlook for these basically revenue durability and growth in some of these COVID-19 categories as we hopefully move into a post-COVID-19 world. The second thing is just maybe address a few loose ends as we think about 2021 financial guidance. And then the third is to talk about capital deployment and how things are looking right now. So with that in mind, why don't we jump into it? Starting on COVID-19, Marc, Thermo is one of the first companies in the world to respond to COVID-19, to respond to the pandemic by providing research and diagnostic tools really quickly. The response rate was rapid, and you did it at really an unprecedented scale. You continue to build out your capabilities with various products and services, supporting COVID-19 vaccine and therapeutic manufacturing. Before getting into the specifics, it would be great to get your high-level thoughts on how Thermo's "platform" put you in a position to basically do what you were able to do over the last year.

Yes. Doug, thanks for the question. And the thank you really goes to the team, right? The Thermo Fisher colleagues, 80,000 colleagues around the world, they saw the challenge and they stepped up to the challenge. So why were we in a position and how do we execute such that when you look back over the last year, we generated $6.6 billion of activity? Certainly, we weren't sitting there and saying, "Hey, we want the activity, but rather how do you mobilize the company to make a difference." And we expect that actually to be about a $7.1 billion opportunity, so a very substantial action. So why, right? First is just the company that we've built over the last more than a decade really has incredible capabilities. And we have this track record of being able to navigate through whatever the environment is, right? And when we saw the pandemic unfolding in China and we were very involved with the Chinese CDC and we were donating product and helping them sequence the virus and all of these things, we mobilized right then to respond globally, right? And effectively, the suite of products and services we had has created this massive opportunity. And when you couple that with the culture of the company, which is we enable our customer success, that's how we measure our success, right, our mission to enable our customers to make the world healthier, cleaner and safer. Our colleagues like, they knew what to do. They weren't looking for central direction, right? They mobilize locally around the world to respond to the pandemic. And then ultimately, maybe the secret sauce of all this was our PPI Business System and just the ability to pivot super quickly and scale manufacturing at an incredible rate. So I'll give you a couple of quick examples. I know we'll sure delve into it, right, which is if you think about the diagnostic challenge, right, which is a new virus emerges a year ago, a little over a year ago, and you need to be able to detect it, right? So we quickly were able to create the kits. We got regulatory approval on the second day of approval that in terms of the diagnostic manufacturers. And we had already done the math well before we got the approval of what the scale of the testing might be, right? And if you frame the right question and you come up with an answer, we deployed our talent to say, this isn't like we're going to develop a kit and sell a few things, but rather, how do you scale ultimately to 20 million kits a week, right? Never ever been contemplated before, right? And -- but we were talking about that in March, right? And things of that sort really made a huge difference and the team executed well. And because of our relationships with the pharma biotech industry on the therapy and vaccine side, we got engaged in over 300 different projects to respond to the pandemic and have scaled up our manufacturing network to support it. So it's been really exciting without missing a beat on the base business, right? We had strong growth in the second half. And so yes, it's a culture, it's a strategy, it's our PPI Business System. You put that all together with amazing people and you get the results that we delivered last year.

Marc, real quick follow-up. And I know it's not this simple.

Sure.

But as I listen to what you just described, and I am going to ask a revenue durability question in a second. But if I think about what you just described, I mean, Thermo had already put itself in a place with unmatched scale and unmatched breadth of relationships. But I still have to believe that what you described essentially probably pulled forward some initiatives that you were working on with customers for a while in terms of just broadening customer relationships, increasing organizational flexibility, building out infrastructure that for now is built to address the pandemic but can be used to address the needs of biological producers down the line. I mean is that a fair way of thinking about this that you were able to respond quickly and do a lot of good? But kind of the tail to this is you pulled forward a lot of relationships and infrastructure and flexibility that otherwise might have taken years to build.

Yes. I mean you asked a question back in September at our analyst meeting about how do we think about sustained value? I think it's very good, right? And it was a nice way to visualize it and probably change the way I articulate the answer to the question, right, which is back in March, when I was communicating both internally and externally, we laid out guiding principles, right? Keep our colleagues safe, enable our customers to work and manage the company so we exit this period a much stronger industry leader, right? That's what we said we were going to do, right? So we pulled -- when we thought about the investments we wound up making, especially as the year starts to unfold in a spectacular way, we pull forward projects that were on the docket and made sense to move to it quicker. Most obvious example would be things like sterile fill/finish and things in pharma services where it's not about COVID, it's about -- it's just great growth in the industry of which we had 5-year road maps on capital, you're able to pull them forward and they'll respond to COVID short term, but they'll transition to other medicines, right? So you have that opportunity. We did that, but you also had these really interesting opportunities to say, "You know what, Thermo Fisher is performing at a much higher level than others." So businesses that might have hit short-term pressure in Q2, we kept the gas on the accelerator on investments, right? We want to have our product portfolios, R&D pipelines be super full. So as the markets came back and they came back quickly, we would be at a competitive advantage, right, relative to others, right? So we did a blend of things. And I'm proud of not only what we delivered in '21, but the way I think about sustained value is this is a company that's going to grow faster long term than it would have grown because of the pandemic, nothing to do with COVID, right, just because of the actions we took, positions a company for a brighter future. So hopefully, it helps.

Okay. Very helpful. Yes, I mean, it's kind of what Thermo has done in periods of challenge in the past, right? I mean it's the same playbook as you followed, I think, '07, '08, where others pulled back and you kept investing to come out of it stronger. So I think that's probably something we should be keeping in mind as we think about '21, '22 and '23 as hopefully, we get to the other side.

Back then, obviously, we had less credibility. So we actually got more -- we had more pressure, like why are you -- why is your earnings growth while good wasn't as good as it could be, all those things and we said, "Hey, we're doing the right thing." We don't get those questions now, right? So we have credibility on the judgment that we're creating both short- and long-term value.

You talked about the $7.1 billion COVID-19 tailwind that you have baked into 2021 guidance assumptions. Included in that is about $1 billion of COVID-19 vaccine/therapeutic-related revenue. So on that specifically, that would be a doubling relative to what you did, that $1 billion is roughly double what you did in 2020. How much visibility do you have behind that estimate? Whether it's orders, backlog, committed manufacturing utilization? How do you capture the possibility of additional vaccine approvals within this number? And then again, to the durability question as we think past 2021, should we -- even though I don't think any of us believe vaccines are going away anytime soon, does that $1 billion have to tail off a little bit just because the initial build-out to support the rollout of vaccines doesn't have to be repeated?

Yes. It's a great question, right? So the $1 billion number, we have a very high degree of confidence that we will achieve that. It's largely driven by firm orders for activity that we have, right? And when you look at the sort of pacing of what we saw last year, you're going to have more sterile fill/finish kind of the final product in 2021, and you'll have a little bit less of that sort of early work on projects that might have failed. There's not a lot of capital equipment in the numbers we did last year, so it's more service or raw materials. And therefore, we have a pretty high degree of confidence in that number. And there's obviously upside to that number. And what we said is -- but it's not going to be like double or triple it because there is manufacturing capacity. So I think there's -- with a narrower range is how we see '21. Obviously, given how many people were talking about vaccine around the world and the possibility that you may need boosters or this may not totally go away, 2022 could be at an even more elevated level. It's way too early to know. But we'll have more capacity online both in cell culture media, single-use technologies and sterile fill/finish to be able to respond to that as well. So hopefully, it gives you a sense of it. And we feel that the $1 billion is a number that we feel very, very good about being able to deliver.

Yes. And maybe saying some of the same things you're saying, Marc, just in a different way. Unfortunately, there's going to be continued demand for vaccine and therapeutics in COVID. And then the infrastructure that you're building out to support these needs ultimately gets used for the purpose of supporting non-COVID vaccines and non-COVID-related biologics, which were amongst the areas of highest growth for Thermo anyway, right? So in terms of any concern about air pocket, presumably, the trend line in terms of non-COVID demand in these categories is probably strong enough where we should feel pretty good about filling out this capacity over time.

Yes. All of the capacity in bioproduction and in our pharma services network that were added is not COVID specific. As you said, and it's totally correct, which is the demand for these business lines are very rapid growing. The bioproduction business is pre-COVID, it's a 20%-plus type grower. Pharma services is kind of a double-digit growth business. And so that will get absorbed. And we had a lot of large customers that have many things in the pipeline actually commit to volume. So that when they couldn't forecast exactly what their COVID needs were going to be, so they basically just reserve capacity and say," "We'll use for COVID as long as we need it, and we'll put other things in your facilities if COVID demand wanes." So we feel good about the ability to pivot to other things over time.

An area where I think there's maybe a little bit more concern or where there's been a little more concern in terms of an eventual clip that's been on the diagnostic side. And I think some of that is rooted in the fact that Thermo is more tied or more indexed to nonautomated solutions. You're evolving the portfolio a little bit, but I think where most of the revenue on the diagnostic side has come from nonautomated solutions. It was interesting though, in our COVID diagnostic panel that we held earlier this week, the experts that we had there actually said they felt like, okay, maybe right now, nonautomated to automated solutions account for kind of 60% to 40% of the market. And maybe over time, that inverts. But those that have built out infrastructure around nonautomated PCR solutions probably aren't going to change in a big way if they're high-throughput labs. So that actually maybe feel like the durability of demand for Thermo products in this category might actually hold up a little bit better than I would have thought beforehand. How are you thinking about this?

Yes. So the interesting thing is we stepped up to support our customers when they needed it and others didn't, and we've done a remarkably strong job of supporting them through the pandemic. Our customers are super happy with us, right? So when demand for COVID goes down at some point, God willing it will, effectively, if you're a customer, your first priority is not to say, "You know what, I don't want to work with the people that actually bailed me out and did a great job", right? And so how does that actually translate into a reality? One is the menu that we had, right? We just got our combo kit approved, right? So kind of the upper respiratory panel of flu, COVID, RSV. You present to your doctor with a respiratory infection down the road and you run that panel. And so we have that, but we'll continue to bring additional clinical content as well. But the other thing is because of the "nature of our platform," which is it's very low cost, you can run lab-developed tests, which the economics of that for the customer are super compelling. So the components of master mix and sample [ all of a sudden purpose things ] will be supported by whatever the customer adds and sophisticated labs do that regularly, right? So we're in a really enviable position there. And then finally, on sample preparation, where we were a smaller player. We wound up being the largest sample prep company last year. And that installed base, all automated installed base isn't going to get turned off, right? And I mean the volumes -- there's never been this level of molecular diagnostic testing on. So volumes will come down at some point, but we'll play a meaningful role. And our expectation is that COVID testing is going to be relevant for a long time, right? Certainly, a reduced diagnostic volume, but surveillance is likely to pick up pretty meaningfully. Certainly, the Biden plan has a lot of surveillance using PCR and you would expect that installed base, which is very active to be able to pivot to that as well. So we're bullish about the prospects and expect to have a nice long tail of revenue going forward as well.

How meaningful is the surveillance opportunity for you between PCR and advanced sequencer?

Yes. So from the surveillance perspective, it should be pretty meaningful, right? It's going to be obviously less than what we saw in the diagnostics side. It's the same kit. We have also an even lower cost version for surveillance, if a customer wants to do that. But we -- because of the way of being able to run 384 samples at a time and being able to pull samples, meaning you can do 4, 5, 6 tests at the same time, we have a very compelling position. I think we'll support the government's initiatives, and a number of governments are doing this for opening schools, right? The U.S. is working on it, France is another country that's working on it, where that they want to have PCR testing to support that. And it should be a meaningful opportunity going forward. And then we complement it with our Mesa Biotech acquisition, where you get effectively an exquisite capability of PCR testing in the point-of-care setting. In 30 minutes, you can get a PCR-quality result. So that will have some applications.

Yes. It's interesting, right? I mean I think the molecular diagnostic deal has been growing at least at levels consistent with Thermo's overall growth rate, if not a little bit higher. At the same time, Thermo, it's been a relatively smaller player within infectious disease molecular diagnostics. I mean I think even though we all hope COVID testing subsides to some extent over time, I mean, I think of the durable benefits that come out of this. I think there's an opportunity for Thermo to be a much bigger player in infectious molecular -- infectious disease molecular diagnostics between what you've done in PCR and then inorganically going out and doing things like Mesa.

[ Maybe we ]...

Maybe just to kind of pull all this together. I mean I brought up the air pocket question. I'm sure you get the post-COVID-19 air pocket question a lot, both in terms of revenue but also as well as margin because some of these are higher-margin areas. It certainly sounds like as we're talking about it, if we're looking for an air pocket, it's not '21 and it probably isn't going to be '22. With that in mind, should -- is the way that we should all feel comfortable about this in terms of thinking about Thermo based on the fact that: one, you can do math as well as we can; and two, you have a pretty good track record of inorganic and organic investment. And you don't like seeing growth moderate and you'd like to grow earnings, and you're going to do all you can do to basically offset any challenges that pop up as a result of the post-pandemic world?

Yes. I mean I fully agree. And it's interesting because I've gotten -- a couple of investors ask me like super specific questions like commit to something in '22. And they said -- and an interesting response I said, you don't want me to commit to something in '22. What you want me to do is manage the company super well to create short- and long-term shareholder value. So if I commit to something, I just eliminated a degree of freedom to be able to achieve that.

Right.

What I know is at the end of 2022, I have to look back and say we did a great job without putting a spin on it, right, and incredibly say, we managed the company super well, we delivered excellent financials, we strengthened our strategic position. And the company, nothing has changed, right? And so whatever year, there's some sort of headwinds for any portion of our business is our job to manage through it and what the exact result will be, I don't know, because I have to understand the circumstances and what the rate responses are. But what I can say is that we're taking the actions to make our base business grow faster, right? And if you think about the evolution, not that long ago, this is a business that we talked about, 3% to 5% growth and 4% to 6% growth then 5% to 7% growth. And if you think back over the last 3 years, it's 8%, 6% and 25%. This year, we're saying 7% is our opening view. So I feel good about what our growth prospects are, especially given the investments, and that will obviously help us offset things as well. So we'll keep our investors updated on what our year looks like, what quarters look like based on what we're seeing. And what I can assure you is that we're taking the actions to strengthen our strategic position, deliver outstanding financials and manage through any headwinds if we see them. And I know that we have the track record and the capability to deal with whatever [ we're seeing of us ].

You referenced the most recent 3-year organic revenue growth target that you provided, which was 5% to 7%. Understandably, you didn't update this at the most recent Analyst Day. That said, yes, we've talked about how the portfolio is evolving. You significantly increased R&D investment in general, but certainly opportunistically through the last period. You also increased sales and marketing and CapEx investment over the past year. As we think about what's been going on in your business, even if we strip out COVID, if you look at pharma and biotech, I think base, whatever you want to call it, but pharma biotech growth, I think, was about 10% excluding COVID last year. You started to see improvement in academic government demand in the second half of the year. You're well positioned and have improved the portfolio within health care and diagnostics. Pulling all these things together, while you haven't provided an update and I don't expect you to outline something completely new today. I mean is it fair to conclude when you pull all these things together that if you were updating today, that you're probably going to be at least 5% to 7% and there's a possibility for it to be higher as you think about the next 3 years?

Yes. I mean that's how we're thinking about it. Back in September, we didn't even give specifics to the upcoming year, this year. It's not to be conservative. This is a volatile environment. And when it's real vol, you're in the risk of just being conservative and then creating a bunch of spin on stuff that doesn't really help anybody. So at some point, we will update our view. And you have 2 different factors, right, that I think our end markets are actually going to be stronger, right? And when you think about the 5% to 7%, that's 3% to 5% market growth plus a couple of points of share gain. My instinct will say, whatever we do, whenever we do the longer-term model mix, that the end market is probably a little bit stronger because of all of the funding interest in the area. And our ability to grow faster than the 2 points of share gain, probably, that's an opportunity as well based on the actions we take. So I think we're super well positioned to be able to go after some very ambitious goals down the road. We're certainly managing the company that way, and we will figure out what's the right time to make that long-term commitment. But I don't think it changes our short-term actions. So hopefully that's helpful.

Yes, it is. Yes. We have the building blocks there, so I just wanted to make sure we weren't overstating or overlooking anything. So that's helpful. I mean another key driver to long-term growth and value is your role as a smart consolidator in this space. You ended 2020 with -- I think it was a net debt-to-trailing EBITDA position of under 0.9x. That's the lowest level we've seen, at least for the past decade. Obviously, things got turbo charged with your response to COVID. So at some level, I mean, you can make adjustments and say this ratio is deflated a little bit because of that. One way or the other, you're in a good position balance sheet-wise, extremely good position. Our estimate is you have at least $30 billion of capacity to employ based on cash flow and historical leverage ratios and how far you've been willing to go. Are we in the right neighborhood?

Right. Yes. I mean we have a tremendous amount of capacity. We always have a lot of capacity, are we on time to do it? Here your model, [ where I was talking ] $25 billion, $30 billion, and we have that ability to do that. Our balance sheet is very clean. And so our industry is very fragmented, right? And we closed 6 deals in the last 3 months, right, and probably put about $1.5 billion, a little more than that to work, of which nobody heard of any of these companies, right? And these are just those normal bolt-ons, right? So there's going to be a steady cadence of that. And over time, periodically, you see larger transactions. So our ability to deploy capital, I think, is excellent. We're very busy in terms of our pipeline. So I feel good about that. And nothing has changed on sort of the mix, 2/3 to, say, 75% on M&A and 1/3 to 25% of return on capital. So we're doing both. I don't see any catalyst to change that. And we bought back a bunch of shares since the beginning of the year, $1.5 billion. We raised our dividend as we typically have done by 18%. So all those good things are happening. And I think you'll see us be able to deploy meaningful capital over time. And while I don't think of it this way, I also think if there's ever a headwind, some of that gets offset by capital deployment, but you don't tie in capital deployment because of future financials. I think it works out in some way, but it's not a financial strategy. It's more just -- we're likely to be busy because we've been less busy over the last year. And therefore, I'm excited about those prospects as well.

The deal pipeline is active as it's ever been?

Yes, it's super busy. I mean you have -- it was dynamic, to be honest, with a lot of entrepreneurs. Last year, it was rough, I mean, for private businesses. Not that the financial was necessarily bad. It's challenging to manage, right? So I think you have a lot of people thinking about is this a time to pass on the baton, right? So I think that in and of itself creates opportunities. And so we're busy.

I mean the flip side to that, Marc, might be, at least on an absolute basis, a lot of valuation multiples are at pretty robust levels, at least versus historical norms. How does that factor into the equation as you think about the pipeline?

So we're a disciplined acquirer, right, and we follow our criteria. It's got to fit strategically. It's got to be valued by our customers. And it clearly has to create shareholder value, and we measure that by our IRRs and ROICs, right? So when valuations are more elevated, you have to believe that you're going to really create a lot of value through the synergies that you get. And in our case, mostly the synergies are growing the businesses faster. There's always some cost, but you have to believe you really can grow something requiring because you're the right owner. If you do that, then effectively, you can create value and valuations are a bit more elevated.

Last one, and this question comes up a lot in my discussions, probably yours as well. I mean Thermo has become such a big company. I think the observation and the assertion is it's getting harder for Thermo to find big deals that can move the needle in the way we've seen with other deals that Thermos done in the past, like Life Tech, for example. Do you agree with that? And how important is that?

Yes. I don't agree with it. I mean FEI was an amazing acquisition, made a difference. Patheon has been phenomenal, right? Brammer is making a difference, right? These things matter, right? It doesn't matter if it's relative to the whole, it might be smaller than it would be in the past. These seem to make a difference for our shareholders. We've got a great team that executes, and that's how we create shareholder value. In an industry that the top 3 companies, still have less than 1/3 of the total. So lots of opportunity here.

All right, Marc. We're going to have to leave it there. It's always interesting. Lots of good things we covered there. We really appreciate the time.

Thanks for having me.